cornerstones 3rd eddition by Hansen, Don R #5 Senior Company currently buys 35,0
ID: 2462686 • Letter: C
Question
cornerstones 3rd eddition by Hansen, Don R
#5
Senior Company currently buys 35,000 units of a part used to manufacture its product at $40 per unit. Recently the supplier unformed Senior Company that a 20 percent increase will take effect next year. Senior has some additional space and could produce the units for the following per-unit costs (based on 35,000 units):
Direct materials $16
Direct labor 12
Variable overhead 12
Fixed overhead 10
Total $50
If the units are purchased from the supplier , $200,000 of fixed costs will continue to be incurred. In addtion, the plant can be rented out for $200,000 per year if the parts are purchased externally.
Required:
Should Senior Company buy the part externally or make it internally?
thank you in advance for you help.
Explanation / Answer
Solution:
Cost of buying the part externally = $40 per unit
Comparative Statement between buying part externally or making part internally
In House Production
Buy from Outside
Direct Material
$16.00
Direct Labor
$12.00
Variable Overhead
$12.00
Total Cost per unit
$40.00
$40 x 120% = $48
Total Units
35000
35000
Total Cost in dollars
$1,400,000
$1,680,000
Calculation of Benefit / Loss if part are purchased from outside
Company will incur additional cost if part are purchased from outside ($1,680,000 - $1,400,000 )
$280,000
Less: Benefit from rental income per year if part are purchase from outside
($200,000)
Net Incremental Loss
$80,000
From the above statement of benefit / Loss, Company will incur loss $80,000 if purchased the parts from outside. Hence it is advised to company to make parts internally .
Notes:
1) Fixed Overhead --- It is fixed nature. It will incur whether company make internally or not make internally the part. Hence it is not treated as relevant cost for decision making.
2) Fixed Cost $200,000 is not relevant for decision making. Hence not considered while evaluating the option.
In House Production
Buy from Outside
Direct Material
$16.00
Direct Labor
$12.00
Variable Overhead
$12.00
Total Cost per unit
$40.00
$40 x 120% = $48
Total Units
35000
35000
Total Cost in dollars
$1,400,000
$1,680,000
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